Down the Rabbit Hole

“In another moment down went Alice after it, never once considering how in the world she was to get out again.”
Lewis Carroll, Alice’s Adventures in Wonderland

Not quite four months ago, the Fed guaranteed lower interest rates and higher stock prices forever.  At least that was the mainstream media’s take on QE3.  The market shot up about 40 points in a day, then did something rather curious.  It stopped.

While the rest of the world took advantage of the pause to shift more money in AAPL, those who study harmonics loaded up on shorts in anticipation of the huge Bat Pattern that was completing [see: The World According to Ben.]

After having reversed at the Fibonacci 61.8% of the 2007 to 2009 crash, SPX had reached the 88.6% level.  Would it be a huge reversal as occurred when the Gartley Pattern completed at the .786 (- 21.6%) or something more modest?

The fact is, we don’t know yet.  After shedding 131 points (8.9%) from September to November, SPX has retraced 119 points — roughly 88.6% of them.

This means that SPX has constructed another Bat Pattern over the past 4 months.

It’s easier to see if we zoom in.

Like the larger pattern that took place from 2007 to 2012, will this pattern deliver a big reversal or something more modest?  For help, we can examine how SPX reacted the last time it reached a major Fibonacci level — the Gartley Pattern at the .786 in May 2011.

SPX lost 112 points to 1258.07 before regaining about 88.6% of them to complete a Bat Pattern (the light blue pattern.)  At that point, it did it all over again (the red pattern.)

In retrospect, the move from 1370 to 1258 was the 1st wave.  The move back up to 1356 was the 2nd, corrective wave.  It was powerful and quick — taking only 14 sessions compared to the 1st wave’s 33.  This fooled a lot of investors into thinking it was a motive wave and was going to establish a new high.

Note: For those of us following an analog that compared the 2011 top to the 2007 top, it was a fabulously opportune time to start loading up on shorts [see: Why Do Analogs Work?]  Our gains over the next couple of weeks were nothing short of spectacular.

The same thing happened a second time (the red pattern.)  The wave from 1356 to 1295 took 7 sessions, while the wave back up to 1347 took only 3.  Again, this suggested higher prices, not the powerful reversal that slashed 246 points in only 13 sessions.

Are there any parallels between the market’s reversal at 1370 and its reversal at 1474?  As regular readers know, I am tracking a new analog [see: A New Old Analog] that suggests there are.  But, there’s a line in the sand at current price levels.

We can argue all day about whether the pathetic fiscal cliff deal, combined with the latest QE incarnation, should mean higher prices.   But, if the latest Bat Pattern doesn’t hold, and prices ramp up past 1474, I’ll consider the analog broken and start charting upside targets.

But, it won’t be because the Transportation Index just made a new high.  It simply completed a Crab Pattern (on negative divergence I might add), imbedded in the tail end of a large Bat Pattern that it’s been trying to complete since February.

And, it won’t be because the Russell 2000 just made a new high — which can also be viewed as a quadruple top (dashed purple TL) that coincides with: (1) a Butterfly Pattern completion (in purple); (2) a Crab Pattern completion (in red); (3) a back-test of a well-formed rising wedge; and, (4) the .786 time fib of the wedge.  All of this, of course, is on negative divergence.

It would be in spite of a dollar index that just broke out of a channel that dates back to May (red), after testing the bottom of a channel (in white) that dates back to Feb 2011.

It broke out of and back-tested the latest channel on the hourly chart, too.

I’ve always wondered what would happen when The Powers That Be threw everything they had at the market and it yawned.  Might that be a rabbit hole from which there is no easy escape?

Between QE3, ESM, Congressional Kumbaya singing…the market should be hitting new highs.  So, why is it mired at the same point (metaphorically, at least) that preceded the last big correction?

The market is currently frozen in headlights, wondering whether to respect the latest Bat Pattern or not.  So, I’m going to take the opportunity to review our analog and general forecast.

To be continued…


Down the Rabbit Hole — 11 Comments

  1. PW, USDJPY hit that first target box in a straight vertical line. Do you think it will retrace (if yes to what level) before going to the next target (91)? If it does retrace, it will correspond well to equity sell off till February, then another launch in both equity and USDJPY…

  2. Wondering about longer term bond yields here.  Yes, they’ve jumped to multi-month highs, but if the market sells off, won’t it force people back into them for safety?  5-wave move down in price (up in yields), so at least a retrace is likely in order.  Plus, BB may want the market to head down to force people back into the bonds to keep rates low.  Rates will kill the country faster than a 10% market sell-off will, IMHO.

    • that’s what i meant by correlations below. a 30 + yrs bull market in bonds can take a complex shape to reverse. but if we start to see old correlations dissolve, then i dont feel comfortable. – if s&p is not falling now, but instead holding on till mid february, then TNX will move up to 2.30 or so. then the sell-off into summer in equties would be wave 2 in yields close to the low we’ve seen. but its hard to say. and you’re right – it’s all about the rates at the end, and they are all about confidence.

    • if s&p is not heading down now, and will take till mid february, dollar would lead as often is the case and normal. so shorting aud now, seems a very good case. or going long vs cad also.

      • yeah, usdcad is a safer pair with obvious support and resistance. If you are a risk taker, take a look at audjpy, straight up for the past month due to yen weakness. Thinking out loud, if spx drops the way PW anticipates, yen should finally find some buying due to risk off, like the old times.

        • yes, i was checking audjpy today. but – i couldn’t get the image – had no feeling about it. but – a good point you make “like the old times” – we have to pay a great deal of good attention to these correlations. also like treasury yields vs s&p. and jpy or cad.

  3. PW – thanks for the update and providing the detailed info on how things have worked in the past. A 170 point drop in 7-13 trading sessions is realistic. 

    I have a trading question for you. I believe you have your portfolio broken in to a core position (follows longer term market direction) and a short term for short trades if the opportunity presents itself. I do this, too. Do you use stops for both your core and ST positions? Are they similar or different? I would be interested to know what works for you – appreciate other members input, too. Thanks in advance.

    • Would also love to hear some general trading strategy like this, stops and managing position size for short term, mid-term and longer term trades, etc. Its a pretty big weakness of mine.

  4. just for the records. i remember times, when the russell made new highs, minor or major, and the s&p did not, that those were the best signals. but – we have to be vigilant, it’s a bloody fucked up market at times.